CHAPTER : 1

Introduction to
Accounting
DEFINITION

“Accounting is the art of recording , classifying and summarising in a

significant manner and in terms of money; transactions and events which
are, in part at least, of a financial character, and interpreting the results
thereof.”
- American Institute of Certified Public Accountants
CHARACTERISTICS

 Identifying financial transactions and events

 Measuring the identified transactions
 Recording
 Classifying
 Summarising
 Analysis and interpretation
 Communicating
 Objectives of Accounting

 Record of financial transactions and events: The objective of accounting is to record financial transactions
and events of the organisations in the books of account in a systematic manner following the principles of
accountancy.
 Determine Profit or Loss: Another objective of accounting is to determine the financial performance i.e.,
profit or loss incurred for the accounting period. It is known by preparing Income statement.
 Determine financial position: Accounting also aims at ascertaining the financial position of the business
concern in the form of its assets and liabilities at the end of every accounting period. It is known from
Balance sheet
 Assisting the Management: Another objective of accounting is to assist the management by providing
financial information to it. The management often requires financial information for decision making,
exercising control, budgeting and forecasting.
 Communicating accounting information to users: Another objective is to provide accounting information
to users who analyse them as per their individual requirements.
 Protecting business assets: Accounting maintains records of assets owned by the business which enables
the management to protect them and exercise control.
 Qualitative Characteristics of Accounting

 Reliability: Means the information must be based on facts and be verified through source
documents by anyone. It must be free from bias and errors.
 Relevance: To be relevant, information must be available in time and must influence the
decisions of users by helping them to form prediction about the outcomes.
 Understandability: The information provided in financial statements must be understandable
by the users. Understandability means decision-makers must interpret accounting
information in the same sense as it is prepared and conveyed to them.
 Comparability: The information should be disclosed in such a manner that it can be
compared with previous year’s figures of business itself and other firm’s data i.e. intra firm
and inter firm comparison.
Role of Accounting

 As a language – It is perceived as the language of business which is used to communicate

information on enterprises;
 As a historical record- It is viewed as chronological record of financial transactions of an
organization at actual amounts involved;
 As current economic reality- It is viewed as the means of determining the true income of
an entity namely the change of wealth over time;
 As an information system – It is viewed as a process that links an information source (the
accountant) to a set of receivers (external users) by means of a channel of
communication;
 As a commodity- Specialised information is viewed as a service which is in demand in
society, with accountants being willing to and capable of providing it.
 ADVANTAGES OF ACCOUNTING

1. Financial Information about Business : Financial performance during the accounting period i.e., profit
earned or loss incurred and also the financial position at the end of the accounting period is known
through accounting.
2. Assistance to Management : The management makes business plans , takes decisions and exercises
control over the affairs on the basis of accounting information.
3. Replaces Memory : A systematic and timely recording of transactions obviates the necessity to
remember transactions.
4. Facilitates Comparative Study : A systematic record enables a business man to compare one year’s
results with those of other years and locate significant factors leading to change , if any.
5. Facilitates Settlement of Tax Liabilities : A systematic accounting record immensely helps in
settlement of income tax , GST etc. since it is a good evidence of the correctness of transactions.
 ADVANTAGES OF ACCOUNTING

6. Facilitates Loans : Loan is granted by the banks and financial institutions on the basis of growth
potential which is supported by the performance.
7. Evidence in Court : Systematic record of transactions is often accepted by the Courts as good
evidence.
8. Facilitates Sale of Business : If someone desires to sell his business , the accounts maintained by him
will enable the ascertainment of the proper purchase price.
9. Assistance in the Event of Insolvency: Insolvency proceeding involve explaining many transactions
that have taken place in the past. Systematic accounting records assist a great deal in such situation.
10. Helpful in Partnership Accounts: At the time of admission or retirement or death of a partner or in
case of dissolution of the firm , the accounting record is to vital importance and use because it
provides the basis to reach a settlement.
 LIMITATIONS OF ACCOUNTING

1. Accounting is not fully exact : Although most of the transactions are recorded on the basis of evidence
such as sale or purchase or receipt of cash , yet some estimates are also made for ascertaining profit or
loss.
E.g.: Depreciation , bad debts etc.
2. Unrealistic Information: Assets are recorded in the books of accounts at historical cost and depreciated over
their estimated useful life. The fact that the assets are recorded at historical cost and as a result, current values
are not shown. Also their useful life is estimated to provide depreciation, it makes the information unrealistic.
3. Accounting ignores the qualitative elements : Since accounting is confined to monetary matters only ,
qualitative elements like quality of staff , industrial relations and public relations are ignored.
4. Accounting ignores the effect of price level changes : Accounting statements are prepared at historical
cost. Unless price level changes are considered while preparing financial statements , accounting information
will not show true financial results.
5. Accounting may lead to window dressing : The term window dressing means manipulation of accounts so as
to conceal vital facts and present the financial statements in such a way as to show better position than it
actually is.
Levels of Accounting

Book keeping

Accounting
Accountancy
 Book keeping , Accounting and
Accountancy

The term “Book keeping ” and “Accounting” often considered as same is not correct. The two
terms are different from each other.
Meaning of Book keeping
Book keeping is a part of accounting being a process of recording financial transaction and
events in the books of account. Book keeping involves :
1. Identifying financial transactions and events
2. Measuring them in terms of money
3. Recording the identified financial transactions and events in the books of account
 Book keeping and Accountancy

“ Book keeping is an art of recording in the books of account the monetary aspect of commercial
and financial transactions ”
-Northcott
Accountancy :
Accountancy is a systematic knowledge of accounting. It explains how to deal with various aspects
of accounting.
Basis Book Keeping Accounting

Difference
Scope between
Book-keeping book
involves identifying keeping
financial Accounting andinvolves summarising the
transactions, measuring them in money recorded transactions and events,
accounting
terms recording them in the books of interpreting them and communicating the
accounts and classifying them. results thereof to the users.

Stage It is a primary stage. Book-keeping It is a secondary stage. It begins where book-

provides the basis for accounting keeping ends

Objective Its objective is to maintain systematic Its objective is to ascertain results of

records of financial transactions. operations and financial position so as to
communicate such information to various
interested parties

Nature of Job This job is routine in nature. This job is analytical and dynamic in nature

Performance It being a routine work can be performed It being a specialised function is performed by
by not so trained staff a trained staff.
Level of skills Book-keeping does not require special skills Accounting requires special skills and ability to
analyse and interpret.
USERS OF ACCOUNTIG INFORMATION

 Internal Users
Internal users are the users who have access to significant information at
the micro level from the accounting records that is useful for
decision making. Following are the internal users and their needs for
accounting information.
1. Owners
2. Management
 INTERNAL USERS

 1. Owners  2. Management
 Owners are the persons who contribute capital in  Management comprise of persons who are
the business and bear maximum risk and get involved in making strategy decisions as well as
maximum reward. running day-to-day operations.
 Since owners have invested capital in the  Management needs accounting information to
business, they need information about how much make decisions such as determination of selling
profit is earned or loss incurred by business. price and strategies such as how to control costs
etc.
 Owners also need such information to decide
whether they should invest more capital in the  Management needs accounting information to
business or withdraw the invested capital from the compare the performance of the enterprise with
business. other similar enterprises in the industry.
 Owner also need accounting information to  Management needs accounting information to
assess safety of their money invested in form of take important decisions to plan future of the
capital enterprise I.e.. expansion, reduction in size, etc.
EXTERNAL USERS

 1. Employees and Workers

They are people who work for an enterprise and are paid wages,
salaries, bonus, etc as remuneration.
 Usually employees are entitled to bonus and increment at the year end
Such bonus and increment is generally based on performance of the
enterprise. Hence, employee Use accounting information to know and
plan about their remuneration and future prospects
 Accounting information also shows whether the enterprise has complied
with the regulations of depositing dues towards Provident Fund Employee
State Insurance, etc.
2. BANKS AND FINANCIAL INSTITUTIONS


Banks and financial institutions are the organisations which provide loans
to business enterprises.
Banks and financial institutions need accounting information to track the
progress of the enterprise so that they can make the following decisions:
1. Whether to lend money to the enterprise?
2. What is the ability of the enterprise to repay the loan?
3. How much money to lend to the enterprise?
4. How safe is the loan given by the Bank to the enterprise?
3. Potential Investors

 Potential investors are the people who are likely to invest in the
enterprise.
 Investors such as banks lend money to the enterprise. Additional funds
required, may be sought from outside parties. Before investing
they look at safety of investment and returns.
 Investors use the financial statements of the enterprise to assess that their
investment secure. Potential investors use the information to decide
whether they should invest in the enterprise or not.
4. Creditors

 Creditors supply goods and/or services on credit to the enterprise. They

assess financial position from the final accounts.
 Creditors use accounting information to assess whether they should.
supply goods/services to the enterprise on credit.
 Financial Statements help them to understand what is the paying ability
of the enterprise.
5. Government and its Authorities

 Various Government bodies and Authorities use accounting information to

arrive at various statistics which enable policy
decisions.
 The Government needs financial statements of an enterprise to compile
information regarding national income, i.e., total income of the country.
This helps them in
making policy decisions.
 The Government levies various taxes on enterprises. To assess whether
correct amount of taxes have been paid by the enterprise, the
Government Authorities need the financial statements of the enterprise.
6. Public

 Public in general is also interested in the financial information of an

enterprise.
 Public needs information to assess the enterprise's contribution to the
economy in many ways ,i.e., employment generated by the enterprise,
amount spent as Corporate Social Responsibility, etc.
 Public is also interested in the financial information of an enterprise to be
aware about the change in its management.
 Public is also concerned whether the enterprise is performing its duties
towards keeping the environment clean or not.
7. Researchers

 Researchers are the people and organisations who use accounting

information for research on various accounting practices.
 Researchers need accounting information to assess current accounting
practices, their improvement and alignment with the evolving world.
For example, new accounting standards are framed and existing ones are
modified in accordance with the practical scenarios.